Materials Management in Oil Industry - This is what you lose

Written by: Artur Osipyan

Perhaps the fundamental purpose of materials management is to ensure that the right materials, of the right quality, in the right quantities, are available at the right time and all of it at the optimum cost. A very challenging task, but it is vital for Oil & Gas operations.

When it comes to materials management in the Oil & Gas industry there is so much room to be better and improve on it. For many years the industry has been lagers when it comes to managing supply chains, hence materials management too. There is a valid reason for that, as an industry, we never had a challenge to effectively move inventory and be flexible and responsive to demand, as there was no financial incentive or reason to do. For many years, the focus has been on ensuring uptime of an asset and / or delivering a project on time, at any cost, which created an industry-wide risk-averseness and almost halted the efforts from an integrated and comprehensive planning to being highly conservative and contingency mindset. As a result, the whole industry tends to build large inventories as a mitigation technique to manage this risk or simply pass this risk to service companies and suppliers. This does not necessarily mean that the risk is removed from the chain, anyway.

Another trend that has been evident for the last decade or so is wider utilization of ERP systems. While the concept of the ERP systems is an excellent way to provide planning, execution and control mechanisms, overreliance on ERP systems may backfire. There seems to be a stereotype that the ERP system will solve a problem. While this is partially correct, a poorly designed system, that is not fit for purpose for a particular business unit, replicate an existing paper-based process and driven purely from accounting perspective, is a recipe for failure.

Another prominent feature is achieving long-term objectives with short-term decision-making became so common that the concept of life-cycle cost might be forgotten or not used effectively.  Looking at projects from a complete life cycle aspect is not new and this is smth Oil & Gas industry have been doing for a long time. In many projects, operating an asset cost a lot more than initial purchase / project cost and may reach as much as 60% of the total life cost. Yet, by large the industry failed to accept that upfront costs are smaller portion of the overall project cost. Because projects are mostly delivered on technically-acceptable-commercially-lowest-bidder basis, future operations become costly, whereby the same field may have multiple manufacturers of similar or identical equipment ( e.g. rotating equipment, pumps), which makes integration and onwards maintenance challenging and expensive.

Managing 3rd party rental equipment and personnel is additional large opportunity area with significant amount of waste. Depending on a number of variables, the numbers can reach up to 10% of the annual OPEX / CAPEX and may translate into tens of millions in lost every year.  Since the focus has always been in getting the job done and ensuring safety and reliability is achieved, the priority shifts away from “sending the equipment back”, to the next “urgent” job. What this have resulted in is equipment been laying around in the jetty or a campsite, or a drilling rig, for no reason - the diagram below illustrates the concept. This effect was multiplied and became more evident in latest industry downturn, when there are fewer people to handle the same workload, due to redundancies.

 

 

Ensuring the most effective flow and storage of materials is challenging and it does not necessarily mean that taking best practices and applying them is a panacea.

Where do significant real opportunities exist? First and foremost, understanding the materials demand characteristics is very important and a very clear distinction should be made between 1) Project driven materials management and 2) Operations / Asset driven materials management. In project driven demand, most of the materials are one-off purchases and the uncertainty risk is very high, which result in material availability risk. Hence, the focus of ensuring availability creates contingencies and surplus that may be magnified when organizations work in silo, i.e. BUs or departments all buying contingency. According to a AT Kearny study most of the CAPEX projects contain 10% of contingency materials, with 50% of those being not utilized, scrapped or disposed otherwise. This is a large cost waste, e.g. on a US$ 1b project, this represent circa US$ 50m.

In operations ( asset) materials management is driven by maintenance philosophies and practices, which make the demand planning, hence materials demand, more predictable and repetitive, which equates to less risk of non availability. What makes operations environment distinct is that materials management here tends to focus on reliability and availability, with less attention to cost and visibility. Focusing solely on availability, without looking into a bigger picture, generally result in overstocking, which equates to higher costs through cost of capital, obsolescence, warehousing and logistics costs, and cost of inefficiencies associated with storage and handling. According to AT Kearny study, upstream companies hold between US$1b to US$2b of stock. A 10% reduction in stock may releases up to US$ 200m in cash, in additional reduced storage and handling costs, and cost of obsolescence. Is it achievable? Surely yes. At the end of 2015, an oil company was able to reduce the inventory items from 158,000 to 75,000 (almost by half!) and storage location dropped from 120 to 48. It may be argued that such a reduction is not sustainable and the law of diminishing returns is there, but it illustrates how big the opportunity is.

 

Our next article in this series will identify the what-and-how, so stay tuned.